Determinants of OTC Trading Volume

Project Start: 05/2013
Status: Completed
Researchers: Peter Gomber, Ilya Gvozdevskiy, Satchit Sagade, Erik Theissen, Moritz Christian Weber, Christian Westheide
Category: Financial Markets, Transparency Lab, Systemic Risk Lab

Topic and Objectives

A considerable fraction of equity trading is conducted in dark markets, i.e. markets with no or limited pre-trade transparency. Such markets include over-the-counter (OTC) markets, dark pools, and systematic internalizers. These markets are subject to less stringent regulation as compared to traditional exchanges and other lit venues. An understanding of traders' order routing choices to different dark venues is a precondition to the analysis of their impact on various aspects of market quality such as liquidity and price efficiency. However, very little research exists on this topic. This project attempts to fill this gap in the literature.

The paper titled “Distinct Dark Markets and the Determinants of their Trading Volume” makes three main contributions to the literature. First, existing theoretical models examining these choices only do so in a simplified setting involving one lit and one dark market. We test the extent to which the predictions of such two-market models hold in a multi-market setting. Second, most studies fail to incorporate the co-determination between traders’ choice of venue and order size. By jointly examining these two choices, we provide additional insights about investors’ trading behavior. Finally, we show that two dimensions along which dark and lit venues differ – immediacy and anonymity – interact with traders’ motives (adverse selection) in explaining order-routing decisions.

We also received a grant from the Europlace Institute of Finance, Paris, which allowed us to extend the scope of the project. This includes the extension of the sample to include additional stocks and an additional paper examining the market quality implications of competition/fragmentation in equities markets.

Key Findings

  • For a sample of liquid European stocks, we study the determinants of trading volume in different lit (open limit order books, call auctions) and dark venues (dark pools, systematic internalizers, and OTC), while also splitting trading activity in these venues into different trade sizes. 
  • We find that the level of immediacy, anonymity, and absorptive capacity across different venues interact with investors' trading motives to affect their order routing decisions and the market share of different venues. 
  • We observe that the relationship between trading activity in the dark markets on one hand, and liquidity and trading protocols on the other hand is a function of traders' preferred order sizes.
  • Order routing decisions and therefore market shares of different venue types depend on market design features, such as tick size, immediacy and anonymity; market conditions, such as liquidity and volatility; the informational environment and trade size.

Related Published Papers

Author/s Title Year Research Area Keywords
Peter Gomber, Satchit Sagade, Erik Theissen, Moritz Christian Weber, Christian Westheide The State of Play in European Over-the-Counter Equities Trading
Journal of Trading
2015 Financial Markets, Transparency Lab, Systemic Risk Lab
Peter Gomber, Satchit Sagade, Erik Theissen, Moritz Christian Weber, Christian Westheide Competition Between Equity Markets: A Review of the Consolidation Versus Fragmentation Debate
Journal of Economic Surveys
2017 Financial Markets, Transparency Lab, Systemic Risk Lab Competition, Fragmentation, Market Structure, Liquidity, Price Discovery

Related Working Papers

No. Author/s Title Year Research Area Keywords
143 Peter Gomber, Satchit Sagade, Erik Theissen, Moritz Christian Weber, Christian Westheide Spoilt for Choice: Order Routing Decisions in Fragmented Equity Markets 2016 Financial Markets, Transparency Lab, Systemic Risk Lab Dark Trading, Fragmentation, Anonymity, Immediacy
35 Peter Gomber, Satchit Sagade, Erik Theissen, Moritz Christian Weber, Christian Westheide Competition Between Equity Markets: A Review of the Consolidation Versus Fragmentation Debate 2013 Financial Markets, Transparency Lab, Systemic Risk Lab Competition, Fragmentation, Market Structure, Liquidity, Price Discovery

 

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